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Highly anticipated inflation print shows tariff hit less severe than expected.
Stocks rose and the Dollar fell after the U.S. reported a headline CPI inflation rate of 2.7% year-on-year in July, unchanged on June and below the 2.8% consensus expectation.
This after the monthly increase from June to July increased 0.2%, undershooting expectations for 0.3% m/m.
For a market anxious about the effect tariff increases would have on U.S. prices, this provides some relief and raises the odds the Federal Reserve will lower interest rates in September.
Battling a stalling labour market, the Fed will feel emboldened to proceed with a cut if it feels the impact of tariffs will be contained.
"Interestingly, the impact of tariffs seems to be less evident in July’s data than in June's. Core goods, excluding new and used vehicles, were up just 0.22% in July, a significant slowdown from the 0.55% advance in June," says Kevin Ford, FX & Macro Strategist at Convera.
Household furnishings, which economists have been watching for tariff effects, saw a monthly gain of 0.7%, a slight slowdown from June.
A drop in short-term U.S. bond yields is reflecting an anticipated reduction in the Fed's base rate, which is in turn sapping demand for the Dollar:
The Pound to Dollar exchange rate rose a quarter of a per cent in the 30-minute window following the data release to quote at 1.3485. Elsewhere, Euro-Dollar rose 0.38% to quote at 1.1642.
"The market’s immediate response to the inflation report suggests some traders had anticipated a more negative outcome. Treasuries rallied, causing two-year yields to fall, as traders increased their bets on a Federal Reserve rate cut next month. The dollar tumbled," says Ford.
Enthusiasm will have its limits, however, as there will be some constraints on the Fed's easing ambitions owing to core inflation. This measure, which excludes food and energy, rose 3.1% y/y in July from 2.9% in June, surpassing a 3.0% consensus expectation.
With services inflation also looking spicy, Fed rate cut expectations will have its limits, which can in turn serve to underpin the Dollar from excessive downside.
"A caveat is needed: the easing narrative could possibly lose steam in September when the next round of key jobs and inflation data is released. Although such a development wouldn't be our base case, an unexpected jump in employment and price growth could put the Fed back on hold, and upset current market calculations," says Karl Schamotta, FX strategist at Corpay.